Posts Tagged ‘incentives’

Our resources are limited. We have to make choices, to get the things we want most with our limited resources. That is rationing. Individually, we must make these choices within our individual resources.

With insurance, we pool our risks with others to provide for occasional extreme expenses. We pay regular premiums, spreading out the cost of major calamities over time and among a group of people within the same insurance program.

Back in the 1930s, medical insurance was rare, if it existed at all. When a medical emergency arose, we went to the County Hospital, supported by local taxes. The quality of care was not the best. I have a stiff elbow to show for it.

I take a dim view of any involvement of government in medical insurance. At the very least, it will add a level of bureaucratic inefficiency to the costs of medical care. At the worst, it will just reduce even more of whatever freedom is left in the medical care market. Say what they may, government involvement means medical care rationing driven by political considerations.

I believe the greatest problem with our medical care is the monopoly (granted by government) which enables the AMA to limit the supply of doctors, and to set rules by which doctors must treat patients. The result is not health care but rather medical care, suppressing symptoms by prescribing drugs. Prevention and cure are not part of the system.

A secondary problem is the close relationship of the AMA, the drug companies, and the FDA, which results in millions of routine prescriptions for expensive, ineffective, unsafe drugs. Prime examples are bisphosphonates, statins, and coumadin.

Providing by law for universal health care insurance will automatically assure that only AMA approved procedures will be covered by insurance. All existing health insurance already does that, but universal health insurance will even eliminate the option to pay as you go for your own health care. Of course, the automatic result of any socialist scheme like universal medical care is to reduce our freedom.

Pay as you go for health care forces you to make economic choices. The result is that you would spend less than you do under full medical insurance. You do your own rationing, according to your own priorities. Doctors and insurance companies prefer the full medical coverage; they earn more that way, and you and I pay for it.

Britain has its own version of universal health care. Through the years the government has tried many ways to limit the ballooning cost. Ultimately, as in Canada, the most effective rationing is the waiting list. When I lived in Britain, in 1999, I needed a knee replacement. The waiting list for that was 20 months. Fortunately, I had private health insurance and had it done immediately.

I feel that total medical insurance coverage, plus the conviction that “doctor knows best”, plus the conviction that the USA has the best health care system in the world, relieves us of responsibility for our own health. We fall in with the medical notion that sickness just happens, regardless of nutrition and lifestyle, and only an M.D. can fix it.

Take charge of your health. Invest some time and effort to learn about, and get, good nutrition. Get up from your couch and TV long enough to get some healthy exercise. Find one of those rare doctors who offer real health care and can see beyond their prescription pad. If you take out medical insurance, take the plan with the maximum deductible and co-pay to keep the incentive to look after your own health.

Having children is not a random accident. It is the direct result of a deliberate act. Other animals, having more sense than humans, refrain from sex when times are bad. But people, in the worst of times and the worst of situations, go on reproducing. In fact, there is a very strong relation between wealth of parents and the size of their families; the poorest families produce the most children.

There are cultures which consider children as an old age pension. This is most common in the poorest areas of the world. In such a culture, there is a definite economic advantage to large families, but essentially, parents are breeding future slaves. That’s not a culture of freedom and as old cultural traditions die out, parents may find themselves abandoned in their old age.

In richer areas of the world, governments actually subsidize children. In the USA, children count as tax deductions. Public schools are supported out of general taxes so education is “free”. The cost is socialized. Public schools may provide free lunches. If you live on welfare, your income increases as you have more children. Dependent children will help to qualify you for food stamps.

In short, government, by trying to protect children from poverty, is subsidizing their parents, making it easier to breed and burdening the taxpayers with the results. This is, of course unfair to the taxpayers, and to the children.

So how many children should each family produce? In a system of freedom, parents should make that decision. But that decision should be made with the realization of full responsibility to prepare the children to become self- supporting adults.

The world is getting crowded. At some point, any additional population will reduce the living standards of everybody. If your thinking is authoritarian, you might call for forced limitation of family size, as China did for many years. If your thinking is inclined to individual freedom, you must accept the right of families to decide. But we shouldn’t tilt the families’ incentives by subsidizing their children. With freedom to choose comes responsibility for the choice.

THE EFFECTS OF TAXES
Many how-to books have been written on ways to minimize your tax bill, and a host of lawyers, advisors, and consultants earn a living by advising us on tax avoidance. Each type of tax influences us in our economic decisions. The income tax in particular is deliberately designed for that purpose, but the sales tax, too, can be tailored to affect your decisions.
Sales tax doesn’t apply to everything you buy. Prescription drugs are exempt. Years ago most foods were exempt. Services may be exempt. You will spend a bit more extravagantly on things that don’t incur that extra penalty of 5 or 6 or 7%. Because of this, the drug companies can hit you for a bit more of your cash than they would if their drugs were subject to sales tax. Yet nobody seems to realize that this is a taxpayers’ subsidy to the drug companies.
For every item that is exempt from sales tax, the state/county/city must simply tax other things a little bit more to make up their loot.
Even more of a subsidy is the income tax exemption for spending on prescription drugs. In this case the subsidy to Big Pharma can be 20, 30, or 40%, depending on your tax bracket. This applies too, to all medical expenses: a big subsidy to medical doctors, hospitals, and makers of medical equipment.
Does this puzzle you? It’s simple. Since the government gives you a tax exemption on such things, you are willing to pay more for them. The Medical fraternity happily charges us more for their goods and services while, to make up for the lost taxes on medical things, the government just taxes us more for other things.
So it goes with the income tax. It gives tax relief to some income (Capital gains) to encourage some of us (mostly the rich) to invest in capital and the growth of the economy, and charges the highest tax rates to the rich in order to be seen to punish them for the crime of being rich, and also to increase the incentive for the rich to invest in the capital market.
So the income tax is designed to control our economic decisions, as well as to provide the funds for the politicians and bureaucrats to spend.
THE STEALTH TAX – INFLATION
At the beginning of the 20th century the word inflation was understood by all to mean an increase in the money supply. This made it all too obvious what caused inflation: The counterfeiting by the banks, under control of the Fed, by command of the politicians in power.
That might be embarrassing for government, but government can “fix” anything. They changed the meaning of the word “inflation” to what is now its universal usage. Now “inflation” is taken to mean the increase in general price levels, (which is really the gradual, delayed result of the increase in the money supply). So politicians can say, “Shame on those greedy speculators, merchants, manufacturers, and unions that are selfishly increasing prices and wages and profits, causing this awful inflation.”
Government spending of the counterfeit cash diverts the means of production to their own purposes, offering high wages and profits to induce people to transfer their efforts to production of what the government wants (Perhaps armaments, men, ships, planes, and uniforms for war).
I worked for many years in the design of military electronics, earning perhaps 10% more than I could in the design of commercial consumers’ goods. The downside of this was the need to frequently find a new job when the current government contract was completed.
As a result of government spending of the stealth tax, there are fewer goods available for the civilian population, while there are more dollars circulating to spend on what’s still available. Prices rise, so that civilians are less prosperous (perhaps even including the ones who moved up to higher pay to work in the munitions industry). The people have paid a very steep stealth tax to fund a war.
So there you have it. Government has contrived to appropriate a very large slice of our income, as painlessly as possible. Robin Hood has a generous salary, plenty of perks and a bit of graft on the side, a secure job which makes few demands on him, and early retirement with a very comfortable pension, all at your expense and mine. And war is always his excuse to increase taxes and expand the power of government.

PATENTS
In a brief economics course many years ago, I learned that monopolies are bad, with one exception. A patent is a grant of monopoly by government to encourage invention and technical progress. That sounded good to me.

In my work designing electronics, I occasionally came up with a design idea which I thought might be patentable. I tried doing my own searches to see if the idea was already patented.

I soon got lost in a maze of legal and technical language and unfamiliar technologies and gave up. What I learned from that was that patents made such broad claims that it would be easy to infringe on a patent without knowing it, and I couldn’t guess whether my idea had already been patented.

I consulted my company’s legal department. The answer shocked me. If I file a patent, my idea becomes public and anyone can steal it and beat my employer to the market. The cost of a lawsuit to defend my patent would be more than it would be worth.

On the other hand, if we use the idea without patenting it, we could have a competitive advantage at least for a few years, until somebody else managed to steal the idea. Even then, they could not patent the idea and block our competition, if we could simply show that we had put the idea to practical use before their patent application.

In time I learned the other costs of obtaining the patent. To prove first conception, trial, and confirmation of the idea required detailed records of progress in development, dated and witnessed daily. The keeping of such records can slow development to a snail’s pace. Then, writing up a proper patent application is a major chore. A patent search to see if the idea is already patented is another major chore for a specialist.

I also learned that some inventors collected patents like trophies to display, rather than to produce a product.

There are companies that don’t invent or patent or produce anything, but buy up patents simply to collect royalties from companies that infringe their patents.

I have already described the effects of the patent system on the Drug industry in an earlier post, “Incentives and Bureaucracy” posted April 11, 2010. The effects of drug patents in our health system have probably caused hundreds of thousands of deaths and untold misery.

All in all, my conclusion is that patents impede progress more than they encourage it, and like all government grants of monopoly, impede our economic progress in order to transfer wealth to a favored few. In practice, patents are not a good thing.

Problem solving is necessary to progress and prosperity. There are millions like me who enjoy solving problems and will go on doing it regardless of monetary reward or special recognition. Business success will favor the most innovative producers, and technology will improve rapidly, unimpeded by the burden of qualifying for patents.

GUILDS AND UNIONS
Guilds and unions are necessary to assure the quality of workmanship, or so they have always told us.
In the middle ages, the Guilds were associations of tradesmen. Goldsmiths, blacksmiths, leather tanners, etc, all self employed, banded together to exclude new competitors, hold down the wages of their employees, and maintain uniformly high prices for their products and services.
A guildsman had no incentive to maintain high quality, or improve his quality, as that would be seen as an attempt to compete against his fellow Guildsmen.
Guilds were government creations. They were granted a charter by the King.
Their nearest equivalent today might be the American Medical Association, which over a hundred years ago was empowered by the government to qualify medical teaching schools and license medical doctors. These powers were sufficient to limit the supply of doctors, stifle competition among them, and control what they learned.
The result is that those who are licensed to practice medicine need not compete. They have little incentive to provide their best efforts. Their monopoly enables them to make buckets of money, so medical expenses take up a very large slice of our income.
Unions a century ago had no political power, so they used violence and intimidation to establish monopolies and extract higher wages, supposedly from their employers, but in effect from the consumers.
In the course of the 20th century, unions gained political power, so the coercive force of government enabled them to limit competition and extract higher wages. But union members feel no incentive to provide their best efforts. At times they intimidate those who do their best because it shows up their own careless attitude. Their pay is set according to their job description and seniority, and competence and effort won’t improve their pay.

ALTRUISM
The miracle of the success of the free market is that it uses our selfish motives to impel us to serve each other efficiently, providing the maximum satisfaction of each person of his own wants according to his own priorities. Would unselfish motives, altruism, serve us any better? I can’t imagine what life would be like if we were all motivated by altruism alone.
Even within the close confines of a family, we find it difficult, even impossible, to know the wants and priorities of others. A bit of obvious evidence of this is the great number of people thronging in the shops after Christmas, to exchange their Christmas gifts for other things. Most people are a bit reluctant to do this; it seems like an insult to somebody who has made a real effort to please us. But even when I tell someone what I’d like for Christmas, I’m often disappointed with the result. Their choice is not what I would have chosen for myself. So I generally give gifts of money, and let the recipient make his own choice. (I’m lazy.)
Perhaps the whole question is irrelevant. People have to be selfish to survive, and although altruism may influence their choices, it is their selfishness which impels them to fill their own wants by serving others to the greatest satisfaction of the others. I think many supposedly altruistic political actions like the minimum wage, the welfare state, and foreign aid, are really selfish actions disguised as altruism. At any rate they often have disastrous results.

The Tragedy of the Commons
The basic principle of socialism is that people must share something: land, goods, income, or responsibility. The various socialist forms of government are: Communism, Fascism, and the welfare state.
The family is the simplest commune. All property, income, control, and responsibility are shared by the parents, but not necessarily equally.
A communist community shares ownership of property, especially the means of production: land, farms, factories, and machinery. It works, but it tends to become a dictatorship, and no member is free.
Fascism is only related to racism and genocide by coincidence; they both existed in Adolph Hitler’s Germany in the 1930s. Both Italy and Spain were fascist, too, at that time, but neither was involved directly in the Holocaust.
A fascist community retains nominal private ownership of the means of production, but governmental control of the economy is so complete that, in effect, the government owns everything and everybody.
The welfare state is primarily about redistributing wealth and income to make the citizens dependent and patriotic. The government’s unlimited power to tax, appropriate, and redistribute income and wealth makes common property of all income and wealth. To the extent that the government controls the economy by regulation and manipulation of the money, the government is fascist.
Common property distorts our incentives. The result is usually exploitation of the property by most of the communal owners, and improvement of the property by few or none of them. Some common property is unavoidable. To avoid wasteful exploitation, all else should be privately owned.
In a free market, enterprise, innovation, and taking risks are the road to riches for the most successful, and increasing wealth for all. Better, cheaper products and services benefit everyone.
Under socialism of any sort, the riches of the successful are taxed heavily. This stifles the incentive to take any risk and so stifles enterprise. Poverty, on the other hand, is rewarded with an extra slice of the common wealth, killing any incentive to try to earn a living. Only the coercion of a totalitarian state can induce workers to bother to even seem to be working. In its efforts to spread the wealth, the Socialist society effectively spreads the poverty.
Through the ages, thousands of socialist experiments have failed because the rules defeated the normal human incentives. People act to improve their lot, but under socialism, any improvement they achieve is divided among 100 or a million others, while without bothering to produce at all, they are still entitled to an equal share- of the poverty.
Of the pilgrims who landed on Plymouth Rock, most died of starvation rather than work for the benefit of others, until the socialist experiment was ended and the people were granted private ownership of some land and whatever they produced. From then on, they thrived. If you favor prosperity, the free market is the only way to go. Socialism is basically slavery. You own a share of a million people and the same million people share ownership of you.

Insurance can be an essential safety net in a catastrophe. Without insurance, death, natural disaster, or personal accidents can wipe you out financially. Savings, in time can build up a buffer against such, but the catastrophe may happen too soon.

Medical insurance, however, in its commonest form today, is not primarily for the occasional and unpredictable event. Much of it goes to pay for fairly routine things like visits to the doctor, prescription drugs, and tests. These are paid for from your insurance premiums, which pass through the insurance company and then to your physician, druggist, and test labs. The cost of all the paperwork involved is added cost, which increases your insurance premium.

More significant than this overhead, however, is the way this kind of insurance changes the incentives of all concerned. You may find yourself blocked off from certain treatments, tests, or drugs because your insurance doesn’t cover them. More likely, you may be getting treatments, tests, or drugs that you wouldn’t choose if you were offered them but had to pay for them yourself.

With insurance coverage, your attitude and your doctor’s attitude is “Why not? It’s covered”. But in the end, your premiums must expand to cover your extravagant decisions, and the extravagant decisions of all the other people with the same insurance.

And most significant, in my opinion, is the way this affects our attitudes to health. Our health care system operates on the idea that sickness, diabetes, heart problems, strokes, cancer, etc, are just random events which call for repairs.

That’s seldom true. These “accidents” are preventable through nutrition and lifestyle. YOU can prevent them. With some personal effort most of us can live and stay healthy and active for many additional years.

Lazily, we prefer to eat junk food that tickles our taste buds, spend long inactive hours at the computer and the TV, get fat and unhealthy, and buy insurance to pay for patching up the accumulated damage.

The foundations of Austrian Economics are spelled out in the book, “Human Action” by Ludwig Von Mises. The whole of Austrian economic theory is based on the single fact the humans act purposefully. Man adapts to his situation by doing whatever he believes will achieve his goals, that is, to satisfy his wants. His situation of the moment provides the incentive for his actions.

For example, man’s basic physical wants, food, clothing and shelter, are not to be had for the taking. They give him the incentive to work to earn the money to buy these things. The purpose of his work is to support himself, his wife, and children.

Of course, in a situation where there is little or no risk of being caught and punished, these wants could provide the incentive to take them from someone else, by fraud, theft, or armed robbery. There are places in the world today where bandits are free to plunder without restraint. In such a place, there is little incentive to acquire wealth by any other means than banditry, since bandits will just take it from you.

There are many more civilized countries today where governments will do the plundering for you. This is the welfare state. Politicians in power, whether by stealth (inflation) or armed robbery (income tax) steal our hard-earned money to buy our votes with welfare.

Even more effective in recent years, the politicians can “buy” campaign contributions by passing laws favorable to special interest groups, in order to get re-elected. Apparently, voters will vote for the name and face most effectively placed before them in the newspapers and on TV. The voters act purposefully but not very wisely.

Basic to all the nasty results of human action is the power of government. That power attracts the worst sort of people and corrupts better people. It corrupts voters who become willing to live off the proceeds from theft, so long as government legalizes the theft. Robin Hood Has moved into City Hall.

Altruistic politicians find they must compromise their ethics to get elected, and then to get re-elected. At best, it enables altruists to force upon us choices that we would not freely choose for ourselves. In the words of Ludwig Von Mises, “Government is the negation of liberty”.